One of the major issues that can prevent a business idea from becoming a reality is the funding needed to get it started. This is also a concern for existing businesses wanting to expand or needing to maintain operating cash flow.
One of the first decisions entrepreneurs need to make is whether to borrow money or offer equity to investors.
Borrowing from banks and other sources forces the entrepreneur to repay the amount borrowed over some period, increasing operating expenses.
The other option is equity financing. Here, the business offers the investor an ownership share in the business.
While there is not typically a scheduled repayment of the investment, the entrepreneur shares in the ownership of the business.
Many entrepreneurs do not want to part with some control of the business.
For those who want to borrow money, there are several sources to which they may look.
First is a traditional bank loan. Loans are available to start a business, and many firms also secure a line of credit to relieve short-term cash crunches.
Tyler Webb, assistant vice president of commercial banking at Old Fort Banking Co., recommends when applying for a bank loan to start a business, "it is very important that there is a business plan in place. The business plan will be one of the things the bank uses to evaluate the ability of the new business to borrow money and make sure that the loans are structured in a way to help the business succeed."
Despite popular belief, the Small Business Administration does not make direct loans to businesses. However, there are a number of public sources of financing.
"Most of my loans recently are a combination of both private and public funding. A small business first approaches a bank to qualify for a loan, and if there is a gap in what the bank is willing to lend and what is needed, then it can approach a public lender to help fill this gap in funding," said Bill Auxter, director of Ohio Small Business Development Center at Terra State Community College in Fremont.
Information about city, country and state sources of funding are available by contacting Auxter.
Venture capitalists and angel investors are other sources of business funding. Venture capitalists are considered some of the most sophisticated investors, often providing knowledge, experience and connections in addition to capital.
Most venture capitalists back companies the investors believe have the potential to be large enterprises.
Smaller entrepreneurs may seek capital from angel investors. These individuals are seeking a higher return than they are receiving in the stock market or bank.
Angel investors can be found through accountants, attorneys and others who work in the business community.
Another source of funding is friends and family. As with equity funding, one of the questions the entrepreneur needs to ask is whether working with friends or family members is a good idea. Those investing often want to be involved in running the business.
Occasionally, there are stories in the business press of entrepreneurs who started successful businesses by borrowing against credit cards. Obviously, high-interest rates make this a more risky alternative, but if the money can be repaid quickly, this can work.
Finally, one of the newer ways to raise capital is crowd-funding, also referred to as crowd-sourcing. For entrepreneurs, this means posting a product or business concept on an Internet crowdsourcing site and asking those who see their post to contribute money to fund the proposition.
In addition to raising money for businesses, crowdfunding is used to raise money for disaster relief, support of artists, scientific research and political campaigns, invention development and scientific research.
President Barack Obama's campaign successfully used a type of crowdfunding through social media sites to raise
campaign funds in 2008 and 2012.
Businesses being funded by crowdsourcing offer some form of incentive to the supporters of their venture such as a prototype of the proposed product.
Most crowdfunding offers do not offer investors equity in the firm or a return on their investment.
Recent legislation may change this restriction, though.
Future columns will take in-depth looks at these funding alternatives. This series will begin next month with a closer look at crowdfunding.
Perry Haan is professor of marketing and former dean of the business school at Tiffin University. He can be reached at (419) 618-2867 or firstname.lastname@example.org.